I have taken the position that Real Estate is not a bubble, but is merely a somewhat extended asset class, driven that way via easy Al and his half-century low interest rates.

That means if (or rather, when) rates return to normal, a 30% give back in value is hardly unthinkable.

If a significant percentage of homes (i.e., %80+) remain owner-occupied, then the downside is more limited. Yes, 30% is quite a haircut, but not when compared to the 78% shellacking the Nasdaq took.

In terms of percentage of speculation, compare Real Estate with late ’90s dot.com stock speculation. My wild guess is that well over half of the owners of Pets.com, Amazon and Yahoo! were mere speculators. I would be surprised if in excess of 20% of recent home sales went to specs.

But since this site is about provoking thought and discussion, let’s consider what

Alan Ableson

Merrill Lynch’s estimable economist (yes, Virginia, there are such things) David Rosenberg. What they show is a) on the left, the stock market’s total value as a percentage of GDP; and b), on the right, household real-estate holdings as a percentage of GDP.

In our rendering, as you can readily see, the peak of nearly 140% of GDP was reached by the equity market in the early months of 2000. That, as you can also readily see, happens to be where the current ratio of housing (aka household real-estate assets) is now, after an extended and almost vertical ascent.

As David observes, a good rule-of-thumb is "to be wary when anything begins to approach or exceed 140% of GDP." (We assume that includes the New York Yankees’ payroll.) He ticks off the various arguments bulls cite as explanation for the great surge in housing and house prices (the latter, incidentally, rose a tidy 11% last year), such as low interest rates, the availability of credit, demographic pressures, a rising tide of immigration — but remains skeptical.

He points out that "much of the move in real-estate valuation has not been due to income generation, per se, but rather due to loose financial-market conditions and an increasing level of exuberance."

He confesses that he gets "nervous when we see things move parabolically north because no asset class at any time every failed to mean-revert after such an upside move." And, while acknowledging he has been bearish on housing for a spell now, points out that just because a bubble "hasn’t burst doesn’t mean it doesn’t exist."

Warns David, "bubbles and baths usually go together." And so, we might add, do burst bubbles and tears.

UPDATE: MARCH 6, 2005 11:23PMInteresting chart from the Economist, which notes that "According to our latest house-price indicators, it is now much cheaper to rent than to buy a house in many countries."

Excerpt:

"According to calculations by The Economist (with the help of Julian Callow of Barclays Capital), house prices are at record levels in relation to rents (ie, yields are at record lows) in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. America’s ratio of prices to rents is 32% above its average level during 1975-2000. By the same gauge, property is “overvalued” by 60% or more in Britain, Australia and Spain, and by 46% in France (see chart).

The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rents back to equilibrium, either rents must rise sharply or prices must fall. Yet central banks cannot allow rents to surge as this would feed into inflation. Rents directly or indirectly account for 29% of America’s consumer-price index, so rising inflation would force the Fed to raise interest rates more swiftly, which could trigger a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 2.5%, house prices would need to remain flat for over ten years to bring America’s ratio of house prices to rents back to its long-term norm. There is a clear risk prices might fall."

>

Source:Tip Of The Camel’S Hump?Alan AbelsonUp and Down Wall Street Barron’s, Monday, March 7, 2005 http://online.barrons.com/article/SB110998285652371176.html

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

12 Responses to “Be Wary of Anything approaching 140% of GDP”

But is the ratio of rental income to home value completely linear? For instance, how much demand is there to rent a $500k home verus to own one? If memory serves, of the top 10% of the population by income, only 3-5% rent versus 30-50% in the bottom 40%. Data on price inflation by market segment might help to tease out the true underlying risk.

Nice matching bubble pictures, but first, they’re on two different scales (across the bottom) and there’s no scale on the left (just the 140% number) What’s the baseline? If it were, say, 135% of GDP on the right, then the change really isn’t that dramatic.

And does ‘Real Estate Assets’ mean value of housing minus mortgage outstanding? Or is it simply the total value of all Real Estate in the US? I’d think that that value would be far, far greater than GDP (and should be)

I find the Economists argument far more compelling. When I bought a house last year, one reason I was willing to pay the (pretty high) price was that the mortgage+taxes could be completely covered by the rent, if it came to that. Seeing what people are willing to pay today really throws that calculation right out the window.

Mecki,
With a little bit of search, I found something from August(?) 2004 which says:
“Since the beginning of 1997, Household Real Estate assets have increased $8.88 Trillion, or 97% (which, not coincidently, is the 7-year percentage increase in residential mortgage debt).”

Now,about those different time scales: the one on the left, the acknowledged bubble, is over 15 years. 1985 is when the bubble is generally acknowledged to have begun. The one on the right, is over 10 years…

Also, your risk is not from what people are willing to pay today for rent, but what people are willing to pay in subsequent years if today’s excellent return on real estate investing creates a property glut and landlords desperate for any income from their expensive, empty units go into a bidding war for renters…

I can’t help but laugh when people say there is no real estate bubble. A sucker is born every minute.

Instead of taking advantage of this low rate environment to clear their debts, dumbells have been refinancing their homes and taking money out of them to further gorge themselves on yet more consumer goods.

The median boomer doesn’t have more than 200K in net assets!!! Do people really think they’ll be able to make their mortgage payments on social security??? The first boomer cohort is just about to retire… with not enough money!

Many boomers say that they’ll just keep on working and won’t retire if they don’t have enough money. But you should see the amount of 50+ I know who can’t find work. Nobody wants oldies and ironically the boomers created this youth-centric society in the frist place!!!

To top it off, 50% of people above 50 suffer from arthritis and that’s just ONE OF THE AILMENTS that afflicts the ageing. The biggest group of boomers is around 45 years old today… 5 years away from pain in their joints. It’ll be interesting to see how many of them will WANT to work when their bodies starts failing them.

North Americans are dreaming in color if they think they can keep up their consumeristic ways. Boomers need to wake up and smell the coffee, and take control over their lives!!!

Sometime, within the next 5 years, you’re going to get a mass of people who will be selling their houses because they will need to downgrade, let it be for financial reasons or health reasons. And if a huge supply of houses were to hit the market, prices will not be going up.

Demographics is the key to what is unfolding. Boomers don’t want to get old and are still living like it won’t happen to them but it will.

I can’t help but laugh when people say there is no real estate bubble. A sucker is born every minute.

Instead of taking advantage of the low rate environment to fix their balance sheets dumbbells have been taking money out of their homes to buy more consumer goods.

The median boomer doesn’t have more than 200K in net assets!!! Do they actually think they’ll be able to make their mortgage payments on social security??? The first boomer cohort is just about to retire… with not enough money!

Many boomers say that they’ll just keep on working and won’t retire if they don’t have enough money. But you should see the amount of 50+ I know who can’t find work. Nobody wants oldies!!! Ironically, the boomers created this youth-centric socielty in the first place.

To top it off, 50% of people above 50 suffer from arthritis and that’s just to name ONE OF THE MANY AILMENTS that afflict the ageing. The biggest group of boomers is around 45 years old… 5 years away from pain in their joints. It’ll be interesting to see how many of them will WANT to work when their bodies starts failing them.

North Americans are dreamers. Boomers need to wake up and smell the coffee, and take control over their lives!!!

Within the next 5 years, you’re going to get a mass of people who will be selling their houses because they will need to downgrade, let it be for financial reasons or health reasons. And if it’s not for these reasons, it could simply be because they get sich and tired of managing 3000 square foot houses and the aides.

Not everyone is going to sell but I’m convinced the supply will be large enough to negatively affect the real estate market.

There is an enormous difference between a company who’s business model consists of essentially a sock puppet, and a home one can live in.

That’s not to say there sin;t speculation here, and that this won’t turn out badly, with a major retracement (25-35% ?) with lots of pain for many — just that I am not convinced that its necessarily a bubble.

I didn’t know there was a globally approved definition of bubble. As far as I’m concerned, it’s only an expression in the first place!!!

And there is no difference in opinion because I agree with everything you wrote apart from the fact that I call excessive valuations bubbles and you want to keep it at overvaluations.

I call this real estate frenzy a bubble because, just like the high tech bubble, everyone only talks about real estate at family reunions and BBQs. I can’t find anyone who thinks they could ever lose money on their home. I call overvaluations bubbles when they happen too fast and could impact the economy in a major way no matter how much the asset prices decline.

If house prices were to stay flat for the next few years, which is in my view an optimistic scenario, it would be negative for the economy. Homeowners would think twice about that costly reno which might not return anything. The trickle down effect could be huge.

I have friends who built their home for 350K three years ago. A year later, they had an offer for 750K from an American. They refused the offer because they wanted a million. Well since then the Cdn dollar has gone from 67 to 80 cents and now they would not be able to get more than 550 or 600K. That’s a lot of money in a small amount of time.

Other friends of ours have built a bathroom in their shed because they don’t want their kids to run through the house all wet. It’s not that it’s that expensive to build a bathroom in a shed but it’s that this is middle-class Canada doing this. Just a few years ago, no one was putting any money into their homes because it was the worst investment one could ever make.

Just a few years ago Canadians were buying 150$ resin patio sets and 100$ barbecues. Today the big thing is 1000$ patio sets and 1000$ barbecues.

Many explain that net worth has gone up but when you look at Statcan’s numbers, the picture is that the savings rate has gone from 6% to 0. Net worth has gone up because housing has gone up and we’re pegging all our nation’s housing at today’s prices but not everyone could get the current price for their house if everyone put their house up for sale a the same time. Our national net worth calculation does not give the true picture of national wealth. Listings have increased by tens of thousans in Montreal in the last few months and things have been slowing down.

For me a bubble is when everyone is doing the same thing at the same time thinking they can’t lose.

You can all call this real estate phenomenon whatever you want, I am still adamant about the fact that many poeple are going to lose a lot of money within the next few years and it will negatively affect the economy. People might not default on their mortgage payments but they might go from wine to beer, from restaurant to Kraft dinner…

In other words, you really don’t know…… Nice…. I say serious losses in some areas as much as 60 to 80 percent causing a banking crisis. RTC 1990s small by comparison.. Long on tangibles (gold, sugar, etc.), short on synthetics (equities, bonds, etc.)… ;-)

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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